The OBE Fallacy

Why OBE,

In the recent few years, we came across new terminology in different industries specially energy industry which is the OBE (Open Book Estimate) as a new approach in executing programs or mega projects. But why this recently was trended by giant clients specially in the middle east.

Before going into why this happened, let us first understand the old or traditional fashion of executing projects, and what is the basic difference between CTR and LSTK?

For decades, LSTK (Lump Sum Turnkey) strategy has been the most widely used model for project execution over the world & specially in Oil & Gas sector. It was the traditional way of any project has the full cycle of engineering, procurement, and construction, wherein the EPC contractor is end-to-end responsible for completing the project within the schedule and with a fixed agreed Lumpsum contract value. Any variation between the initial estimate and the actual costs is to the contractor account. Any shortage or economic fluctuations, price changes….etc is the contractor’s risk.

So, LSTK transfers all the risks from owner to contractor, and the latter must bear all risks.

Cost+ or CTR (Cost Time Reimbursable) model is where the owner pays the contractor as per actual cost with an additional agreed percentage as a markup fee to cover the contractor overheads and profit margins.

In this case, Owner takes the risks, as he has to pay, irrespective of fluctuation in price, inflation,..etc, but in other hand if there is reduction in cost it will be an added value to Owner.

In all the past projects, the bidding process was based on LS basis, in which the owner invites all contractors to bid for the scope of work as LS without break up and the owner selects the most optimum techno-commercial offer.

why now?

In the last 4 years, there was an unexpected pandemic, followed by a war, and now an economic crisis which were never expected. Even the most experienced economists are not able to predict the coming month, not even after 5 years.

Nowadays, whenever you approach any vendor or contractor, they cannot guarantee the price for more than few weeks. Before war, we, as buyers, used to ask vendors for 3–6-month price validity, and we used to ask vendors for bank guarantee to ensure he has enough backlog/liquidity to produce & deliver the order obligations. Nowadays, it is completely the reverse situation; vendors are asking buyers for bank guarantees to ensure that they can pay his invoices.

What a twist in the situation!!

With these circumstances in the market condition & general economy, no one can ever expect the inflation or fluctuation in the economy and strategic goods, so your risk profile as a contractor or vendor is ?increasing and, thus, your risk margin will be very high and can touch up to 50% of the total budget which has never happened in history before.

Now, the new concept of OBE has become a trendy in different industries, the new OBE + CTR accomplishment model provides complete transparency and agility for mid-course correction, where all the payments are made based on OBE Contractor’s recommendation and generally through the ESCROW account. Payments to the vendors/sub-contractors/construction contractors are released through this account only. In the OBE Model, there is flexibility towards mid-course correction and ease of contract management.

?The other advantage of this model is that the owner gains deep insight and technological understanding during the project stage and has the overall control of the project & procurement side, & also release the contractor & vendors from bearing the unexpected risks.

What is the optimum successful approach to implement this Model?!?

Normally, the owner asks contractors to provide a detailed cost estimate, which is defined based on the Association for the Advancement of Cost Engineering (AACE) the international practice No 18R-97 for the cost classifications, which defines the cost estimate as 5 classes based on accuracy & maturity of the estimate, and gives clear list of pre-requisites to achieve every class.

Then Owner place a (CTR) cost time reimbursable contract with a ceiling of +/- XX% (generally 10-15%) which is agreed upon between Owner & Contractor. If, after execution, the cost is beyond this agreed ceiling, Owner has to approve in advance and has to pay to complete the project but it will have some LDs or deduction of % of the contractor payments if it is contractor fault like wrong estimation or sizing…etc, but if it is external factor like economy, prices, inflation…etc. then no penalties on contractor.

In the other hand, if it is less than the agreed cost estimate, then this profit passes on to the owner with some % as a bonus/incentive to the contractor.

However it is human nature that no one wants to keep it open ended, & all owners wants to limit the budget without bearing the risks & transfer all the risks to contractor account…..!

The worst case ever is the convertible LSTK, which convert this OBE to Lump-sum, without bearing any attention to the risk profile. For example, if the OBE came up with an estimated cost as X$, and to accumulate the budget you need Mont-Carlo calculated Risk margin, management reserve & profit. With this model Owner push the contractor to lower his risk profile as he will not agree to increase the risk more than 5% & enforce him to face all the threats and uncertainty with very minimal risk margin, it’s like you are inviting contractors to a Russian roulette. What a loss…..!!!!

As every model has some pros and cons, these two models also fall into the same category. Like, In LSTK, the client has less involvement, as all responsibility/liability lies with the EPC contractor to complete the project. In contrast, in the OBE-CTR model, the complete involvement of the client is required at all stages. Not only that, but LSTK model is motivating contractor to do value engineering, optimization….etc. in order to win in the competitive bid.

Recently in the energy sector for the 2 mega projects or actually programs in the middle east, it was proven that this OBE convertible to LSTK is the worst execution approach ever in the industry, & big clients start paying for this wrong trendy execution model…….

Lets use this as lessons learned t to be more transparent & agile in strategic thinking & try not use the traditional mindset of (High Risk means High Profit), the risks now are beyond possibilities.

lets go with scientific and calculated strategic steps towards successful projects.

#Almostafa_Abdelfatah

#epc #OBE #oilandgas #contracts